UAL-US Airways Not Over Yet - 2001-07-16

Travel buyers reacting favorably to the apparent collapse of United Airlines' merger attempt, which many feared would sacrifice competition and customer service, got surprising news late last week as United announced it would continue to pursue its proposed $4.3 billion merger with US Airways. United said US Airways rejected its recent proposal to scrap the merger deal.

Both United and US Airways late last week also provided the U.S. Department of Justice with the 21 days advance notice the department requires before it will provide a determination of its position on the proposal.

Perhaps accounting for United's reversal is a termination clause in the current agreement that stipulated that after Aug. 1, United could walk away and pay only a $50 million break-up fee. It is unclear what compensation US Airways would have sought before that date, but printed reports indicated that United asked US Airways to limit the penalty to that $50 million. However, some analysts and politicians speculated that United had dragged its feet as the merger--and US Airways' stock price--became decreasingly favorable.

Though consumer groups, some government officials and business travel buyers generally reacted favorably to United's intention to pull the plug, some companies using both carriers are still hoping for simplified contracting.

"We were back to concentrating on meeting commitments without the distractions of all the bureaucracy," said Doug Baldy, coordinator of corporate travel services at Eastman Kodak in Rochester, N.Y. "We had a little bit of relief thinking this is over.

The Business Travel Coalition released a statement, saying consumers, communities and businesses should be encouraged that the two carriers might not pull off the deal. "The fundamental benefits of 23 years of U.S. airline industry deregulation were at significant risk," the group said.

"Bigger is worse as far as buyers are concerned, so they should be pleased if it doesn't happen. In the long term, it means less overall consolidation and more competition," said John Heilner, vice president of Management Alternatives/MSIG in Princeton, N.J. "American and United would be so dominant that it would be scary. Buyers certainly would be better off without a merger."

For its part, American, which would stand to acquire pieces of US Airways as part of the deal, indicated in recent weeks that it would be content without the deal, especially after its acquisition of failing Trans World Airlines and newfound position atop the industry.

For United--which has struggled with customer service, on-time performance, labor strife and waning public and corporate client confidence--governmental rejection of the merger would be both good and bad for the country's second largest carrier.

On the one hand, United would stay behind American in network size, lose millions of dollars spent preparing for the merger and miss an opportunity to significantly grow its customer base and passenger revenues. On the other hand, United would avoid nightmarish integration efforts that likely would further drain its financial resources already under pressure from successive and significant quarterly losses. It would no longer face the prospect of striking flight attendants who threaten to walk out should the merger be consummated, and it could focus on getting its own house in order without further alienating travelers by levying higher fares to fund the merger.

"It would be a win-win for consumers," Heilner said. "Competition would be stronger and travelers would not have the short-term headaches of labor integration."

Analysts, too, said a successful merger would make the situation worse for United before it could see the benefits in the long run. "We have viewed the proposed acquisition of US Airways as disastrous for UAL's short-term earnings," said UBS Warburg analyst Sam Buttrick in a research note to investors. "With the deal likely terminating, the risk of massive short-term dilution would be gone."

United's options moving forward, should the merger not occur, could include a looser US Airways marketing agreement, purchasing smaller chunks of US Airways or looking at smaller acquisition targets.

US Airways' board of directors, meeting this week, clearly decided to hold United's feet to the fire. Though chairman Stephen Wolf and CEO Rakesh Gangwal seem to have put all their eggs in the merger basket, if it does not happen, the airline could opt to sell off pieces to interested carriers, of which there are several, particularly for its Washington-area assets and its Northeast shuttle. The board also could choose to restructure management, ownership and operations to survive against an onslaught of low-fare carriers in its core operating region.

The carrier's cost structure is one of the highest in the industry and chairman Stephen Wolf repeatedly has said that the carrier cannot survive as is. "If there is no plan B, then many industry observers think Wolf and company should be replaced for mismanagement," noted the BTC. "If there is a plan B, then Wolf has seriously misled the federal government and the airline's employees, customers and other stakeholders."

While mounting quarterly losses are a testament to US Airways' ongoing difficulties, most analysts believe the carrier can retool and stay the course. "We do not view US Airways as the basket case that it has been portrayed as for political expediency by current management," Buttrick said.

He added that United-US Airways is "the fulcrum" of domestic consolidation. "If they can't clear the regulatory hurdle on economic terms, then we believe that neither would any combination of a top three carrier with any of the middle three," he said.

Northwest Airlines CEO Richard Anderson echoed that assessment, saying that if an earlier Northwest attempt to link up with Continental Airlines did not receive a green light (BTN, Nov. 13, 2000), "then how did United-US Airways have a prayer?" Anderson told BTN that he is content with Northwest's "very strong position" in the current industry pecking order, primarily due to its underdeveloped hubs and ongoing marketing alliance with Continental.

With industry consolidation apparently cooling, buyers generally expect more competition and aggressive contracting from carriers. "No merger would not be a bad thing for companies in Washington, which would've been in tough shape with United-US Airways dominance. And here in Philadelphia, there wouldn't be some of the transcontinental competitive issues," said William Patient, a travel buyer for Atofina Chemicals in Philadelphia. "For me, I'll have to negotiate two contracts instead of one simplified deal during annual renegotiations. Individually, the carriers would be more aggressive, but it would be difficult to tell if it is because of the failed merger or the economy."

Kodak's Baldy, who also deals with both carriers, said competition on his top city pairs will continue with or without the merger, with a few exceptions, such as Philadelphia. However, he noted other benefits, including the possible elimination of customer service issues that "drove our travelers crazy last summer" when United canceled thousands of flights.

"The biggest problem we've had is that our United account manager is involved in the merger planning and not available to us. So we'll be happy to have him focused on Kodak again," he said.